Mongolia mines a rich seam

By bne IntelliNews September 23, 2010

Ben Aris in Ulaanbaatar -

The hill that runs along the side of Ulaanbaatar, the capital of Mongolia, is still covered with yurts, the nomadic tent houses that have been used for millennia by the peoples of the steppe. Some stand in the lee of the power station on the hill and the wires overhead crackle with electricity.

Its four o'clock and school children in uniform pick their way through the dust and rubbish on their way home to their families in the yurt that often house up to eight people. The number of tents has actually increased this year following a "zud" winter in 2009, the Mongolian term for an extremely snowy winter where the livestock can't find food. Many of the new arrivals lost up a third of their animals, slaughtered the rest and moved to UB - as the locals call the capital - to look for work.

Mongolia started this millennium as one of the poorest countries in the world, but since work started on the Oyu Tolgoi (OT) copper-gold mine earlier this year everything has changed. The prospects for the herders in the yurts has improved dramatically in just the last year as the investment from just this one project already lifted the economy by a fifth and will drive growth for the next three years. But when the mine comes online in 2013, the economy should explode.

Mongolia is a cornucopia of untouched natural resources. The OT mine is the investment that has primed the pump, but the catalyst that pushed the government into action has been the global economic crisis, and the phenomenal growth in next-door China will provide the fuel for what should become the success story of the decade.

Spurred to action

The government has dithered over the OT mine since copper and gold was first discovered there over a decade ago. However, the crisis spurred the Great Hural, Mongolia's parliament, into action last year when it signed off on a massive investment and development project for the deposit with Canada's Ivanhoe mines. The British-Australian Rio Tinto group also has a stake in the mine, which holds more than 37m tonnes of copper and 46m ounces of gold in measured, indicated and inferred resources.

The foreign partners own 66% of the mine, while the Mongolian government holds the rest. This year the partners will invest about $750m into building the facility in the southern Mongolian desert close to the Chinese border and the investment will only climb from there. "The first pound of copper is not due to be produced until 2013, but by then more than $3bn will have been invested into the mine in an economy which creates $5bn of wealth a year. It's a massive injection of cash for Mongolia and foreign exchange inflows this year are already up an order of magnitude over last year," says Naidansuren Zoljargal, deputy governor of the Bank of Mongolia.

Work on constructing the OT mine is already well in hand. The exploratory Shaft 1 has been completed, which is being used to better define the size of the deposit. Work on shaft 2 has already started, which will be able to carry over 1000 workers to the mine face and enable the extraction to start in about two years.

The rising tide of money is already being felt on the foreign exchange markets, where the national currency, the tugrik, has already started to appreciate strongly against the dollar. As the money keeps coming, the main challenge for the government is how to deal with all the cash flooding into its coffers.

But the real boom will arrive at the end of 2012 when the mine is expected to go online and the shipping copper and gold starts. At full capacity, OT is expected to generate some $3bn a year of revenues (at current prices), single-handedly increasing the size of the economy by half; the government is forecasting between 7.5% and 8.2% GDP growth for the next two years, but growth will leap by 20.8% in 2013 after OT starts functioning before settling down to around 14% growth a year thereafter, according to Mongolia's national development and innovation committee.

And OT is not the only mining project. China's push to develop its northeast regions is sucking in every raw material Mongolia has to offer - and that is a lot. The country's vast copper, gold, PGM group metals and coal resources remained largely untouched in the Soviet era, as Russia produced all it needed for both internal consumption and export from its own territory. The one exception was the huge Erdenet copper mine built by the Russians in 1975 to exploit Asia's largest deposit of copper ore and the fourth largest copper mine in the world, which has been Mongolia's main source of hard currency earnings for the last four decades.

Coal face

OT is a big political deal that will kick start the economy, but now the country is rapidly opening up, spurred by China's rapid renaissance, and the first resource to be developed on a more commercial basis is coal.

Coal as a fuel has made a dramatic revival in recent years in a world worried about energy security. And the fact that 80% of the fuel burnt in Chinese power stations is coal helps. Even the domestic demand for power is going to spike. In the last 30 years, Mongolia has not added a single power plant to its 800 megawatts (MW) of capacity today, but demand is already at 700 MW and the average consumption of power is rising fast from an extremely low base of 0.6 kilwatt (kW) per person against the averages of 1.6 kW in China and 6 kW in Germany.

Prophecy Resource Group is developing the Ulaan Ovoo coal deposit in central Mongolia, among others, which contains about 209m tonnes of coal close to the Russian border that is covered by only a few inches of dirt. The coal is of such high quality it doesn't need to be washed and can be shipped out to customers immediately. CEO John Lee literally doesn't have to do anything more than go to the site and start shovelling coal into a wheelbarrow to work to toward the first 50,000 tonnes his firm will produce in November. Ultimately, the mine hopes to produce 5m tonnes a year and go from an operating cash flow of $1m this year to $172m by 2014. "There are coal deposits all over Mongolia, most of which are now being developed by a slew of companies," says Lee. "Yes, coal has a dirty reputation, but with today's technology it can be made clean."

Copper produced at the OT mine will reboot the Mongolian economy, but coal should ultimately overtake it as the main economic driver: 7m tonnes of coal was produced in 2009, but that number is expected to increase 10-fold over the next few years to 70m tonnes of mixed coal, worth at least another $7bn a year in revenues for Mongolia, at today's prices. "Copper is going to be the main forex earner for the next few years, but a little further down the road, coal will become the most important export," says Steve Feldman, head of IR at South Gobi Energy Resource. "We have closed deals to develop a large area and China is hungry for coal. It is a captive market."

Investors are still playing catch-up with Mongolia's coal developments. South Gobi listed on the Hong Kong Stock Exchange in January, raising $400m, which values its coal at $5.70 per tonne against an average marketing price of about $100 per tonne. However, Prophecy is also listed on Toronto's exchange, but enjoys little coverage by analysts, which is reflected in its share price, which values its coal reserves at a mere $0.04 per tonne of coal, says Lee.

Mongolia is still right at the beginning of developing these resources and most of the coal projects won't start coming online until next year at the earliest, but together they will add to the money flowing into the economy from the OT mine the few paying attention to the story say the growing affluence will quickly spill over into the rest of the economy as it has done elsewhere in resource-rich economies. "Billions of dollars will be pouring into the country in the coming years as all these project get going. It is going to spill over to the banks and the real estate sector and the whole economy will be lifted," reckons Ganhuyag Hutagt from the TenGer Financial group, who is also an economic advisor to the prime minister. "The biggest challenges we face going forward is building up the infrastructure and how to handle all this money that is on its way so we don't succumb to things like the Dutch disease. Still, these are not bad problems to have."

Mongolia mines a rich seam

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